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No Summer Vacation for Distributed Ledger Technology

As regulators across the globe turn their attention to distributed ledger technology (DLT), developments in this space have been in the news almost weekly this summer. In the past six weeks alone regulators in the United States, Canada, Singapore and China have paved the way to exercising jurisdiction over initial coin offerings, actively demonstrating a keen interest in the development of DLT. As the UK’s Financial Conduct Authority (FCA) predicted in its April 2017 discussion paper on the topic, it appears that DLT is transitioning from a proof-of-concept phase, to real-world deployment.

As mentioned in our client alert of 2nd March, regulators across the globe are turning their attention to distributed ledger technology (DLT). Developments in the DLT and cryptocurrency space have been in the news almost weekly this summer. In the past six weeks alone: (i) Bitcoin split into two currencies; (ii) the Securities Exchange Commission (SEC), the Canadian Securities Administrators (CSA), and the Monetary Authority of Singapore (MAS) paved the way to exercising jurisdiction over initial coin offerings (ICOs); (iii) a committee led by China’s central bank denounced ICOs as “illegal fundraising activity”; (iv) ISDA released a white paper on distributed technologies’ application to its master agreement; and (v) one of the world’s largest options exchanges announced the offering of cash-settled Bitcoin futures.

This year, regulators are demonstrating a keen interest in the development of DLT and appear to be weighing the appropriate degree of regulatory oversight. In February 2017, the European Securities and Markets Authority (ESMA) published a report stating that any regulatory action in this field would be premature. However, across the Atlantic regulators are slowly seeking to test the waters in this regulatory whirlpool. If the speed of this summer’s activity in the United States is anything to go by, it will not be long before European regulators follow suit. In just the first two months of 2017, the U.S. Financial Industry Regulatory Agency (FINRA), ESMA, and the International Organizations of Securities Commissions (IOSCO) all issued reports on DLT. Just six months later, (and as the UK’s Financial Conduct Authority (FCA) predicted in its own April 2017 discussion paper on the same subject), it appears that DLT is transitioning from a proof-of-concept phase, to real-world deployment.

Recent Occurrences

5 June 2017 – Nevada passes bill clarifying blockchain’s legal status

Nevada passed Senate Bill 398, clarifying blockchain’s legal status under state law. Following the example set by Arizona’s passing of blockchain-related legislation earlier in the year the law, among other things, recognises that blockchain records have legally binding status. The law also prohibits local governments from requiring a certificate, licence, or permit to use a blockchain. The passing of such state laws typifies the added vigour with which policymakers are engaging with this technology. For more information, please see our client alert on this topic.

Exactly one year after the European Commission adopted a proposal to bring virtual currency1 within the scope of Fourth Anti-Money Laundering Directive (MLD4), the Italian AML Decree2, which implements MLD4, came into force. Among other things, the decree brings ‘virtual currencies’ and ‘virtual currency services’ within the scope of Italian AML laws. It is anticipated that the European Parliament will vote on the proposals to bring virtual currencies within the scope of MLD4 in the coming months. If passed, all member states will be required to bring virtual currency within the scope of their respective national regimes, further narrowing the regulatory gap between the EU and United States for cryptocurrency.

17 July 2017 – FCA DLT discussion paper closes

The FCA discussion paper on DLT closed on 17 July 2017. As outlined in our client alert on this paper, the FCA is now reviewing comments on the discussion paper with a view to publishing a summary of responses or a formal consultation paper. This discussion paper marked the fourth publication in a library of global regulatory reports on DLT, as FINRA, ESMA, and IOSCO also published papers earlier in the year.

The Commodity Futures Trading Commission (CFTC) recently issued an order3 granting the cryptocurrency trading platform LedgerX registration as a derivatives clearing organisation under the Commodity Exchange Act. Earlier in July, LedgerX was also granted an order of registration as a swap execution facility. LedgerX is the first federally regulated digital currency options exchange and clearinghouse in the United States. It has announced that it is set to launch options trading for cryptocurrencies in September, offering investors the ability to invest in cryptocurrency on a regulated platform.

25 July 2017 – SEC exercises its jurisdiction over initial coin offerings - ASIC, MAS, the CSA, and the People’s Bank of China also speak out on the topic

USA

The SEC released an investor bulletin declaring that virtual coins or tokens offered or sold as part of an ICO may be treated as securities, and therefore subject to federal securities laws4. The SEC added bite to this bark by declaring that the tokens offered by The DAO were securities and should have adhered to the relevant securities law requirements. Some maintain that this was a positive step, and predict that regulatory oversight could predicate the legitimacy that widespread acceptance mandates5. For more information, see our client alert on this topic.

The decision was issued less than a week after Fintech research provider Autonomous NEXT published a report revealing that over US$1.2 billion in cryptocurrency was raised in the first half of 2017, far outstripping the total figure for the entirety of 20166.

Australia

In the wake of the increase in activity, the SEC is not the only regulatory authority to have spoken out on ICOs in recent months. In June 2017, the chairman of the Australian Securities Investment Commission (ASIC) said that he would take a technologically neutral approach to ICOs, noting that they would be treated no differently to the issuance of more familiar financial instruments if they have the same characteristics7. ASIC has also warned against any premature moves to regulate such offerings without a comprehensive understanding of the underlying technology.

Singapore

On 1 August 2017, the MAS clarified that the offer or issue of digital tokens in Singapore will be regulated if the digital tokens constitute products regulated under the Securities and Futures Act8.

Canada

The CSA has also released a statement9 on cryptocurrency offerings, stating that it has “in many instances found that the coins/tokens in question constitute securities for the purposes of securities laws, including because they are investment contracts”.

China

On 4 September 2017, a committee including the People’s Bank of China and the China Securities Regulatory Commission released a joint statement10 stating that ICOs are illegal fundraising activity. Among other things, the statement said that: (i) China will shortly issue a ban preventing all organisations from raising funds through ICOs; (ii) financial institutions should not do any business relating to ICO trading; and (iii) those companies that have raised funds through ICOs should make arrangements to return those funds. The long-term impact of the announcement remains to be seen, although it has been reported that some Chinese ICO platforms, for example ICOINFO, have halted ICO related activity.11

1 August 2017 – Delaware permits the use of blockchain technology for stock trading and record keeping

Following the passing of blockchain-related state laws in Nevada and Arizona, Delaware passed amendments to its General Corporation Law to give companies registered in the state the right to issue and subsequently trade shares on platforms underpinned by blockchain technology. The amendments mean that shares issued using DLT will be legally recognised as uncertified securities. The fact that the U.S. state with the highest number of registered companies (Delaware is home to over 65 per cent of the listed Fortune 500 companies and 85 per cent of the USA’s IPOs) has expressly permitted the use of DLT in both trading and governance represents another significant milestone in the permeation of blockchain in traditional corporate systems.

1 August 2017 – Bitcoin splits underlying software code

It had been widely reported during most of this year that the insatiable demand for Bitcoin had tested the underlying blockchain’s capacity. Some miners, armed with the belief that transaction volumes had become unmanageable, therefore created a new version of the currency called Bitcoin Cash. It is claimed that Bitcoin Cash allows eight times the amount of data to be added to its ledger of ownership than Bitcoin. It is likely that proponents of Bitcoin Cash will spend the coming days and weeks securing the credibility of the new digital currency. In the meantime, the price of Bitcoin eclipsed US$5,000 for the first time12.

2 August 2017 – CBOE announces Bitcoin futures contracts

In the wake of one of the most turbulent weeks in Bitcoin’s short history (see above), North America’s largest options exchange, the Chicago Board of Options Exchange (CBOE), announced that - subject to regulatory approval - it is set to launch cash-settled options and derivatives on Bitcoin. To facilitate this offering, CBOE has agreed to an exclusive market data licence agreement with the Gemini Trust, a virtual currency exchange run by the Winklevoss brothers and regulated by the New York State Department of Financial Services13. Following the SEC’s rejection of the Winklevoss Bitcoin Trust exchange-traded fund14, this will mark the second time this year that a digital currency venture backed by the Winklevoss brothers has faced scrutiny from U.S. regulators.

3 August 2017 – ISDA publishes whitepaper on applicability of the blockchain

The International Swaps and Derivatives Association (ISDA), the world’s leading provider of swaps documentation, published a white paper considering whether the ISDA Master Agreement could be, in part, coded by smart contracts - representing a significant initial step in the interoperability of blockchain technology and established derivative processes15. For more information, see our client alert on this topic.

8-10 August 2017 – Digital currencies milestones

Following an announcement by the online retail trader Overstock, owners of a multitude of digital currencies will be able to use their coins to buy everyday items, from furniture to jewellery. The Salt Lake City-based company, which has accepted payment in Bitcoin since 2014, became the first major retailer to accept payment for its goods in all major digital currencies, including Litecoin, Bitcoin, Ethereum and Bitcoin Cash. In the same week Coinbase, which allows individuals to buy, sell and hold many of the abovementioned cryptocurrencies, became the first cryptocurrency unicorn16.

11 August 2017 – Bitfinex announces it will limit services to U.S. customers

Bitfinex, a major cryptocurrency exchange that was the subject of a CFTC enforcement action in June 2016, announced that, from 16 August 2017, it will no longer allow U.S. customers to purchase certain products through its platform due to recent regulatory developments17. Bitfinex anticipates that the U.S. regulatory landscape will continue to pose challenges to the exchange and is concerned that certain tokens offered on its platform will be considered ‘securities’ by the SEC. It expects the SEC to continue to apply the securities laws and regulations to ERC-20 tokens issued through the Ethereum blockchain. Other exchanges that list tokens sold via ICOs and permit U.S. customer access may begin to follow Bitfinex’s lead, or may otherwise comply with securities law requirements. Given the recent statements by MAS, the CSA, and ASIC, these exchanges may be further limiting their customer access to comply with regulators’ requirements around the globe.

August 2017 – SEC suspends trading in securities of three blockchain-related companies

Following on from its statement in July that the DAO ICO should have adhered to securities laws (see above), the SEC suspended trading in company securities of three publicly traded blockchain-related businesses. Further, the SEC released an investor alert that provides a list of facts that it considers in evaluating whether a trading suspension is appropriate18. The companies affected by the trading suspensions include First Bitcoin Capital Corp., CIAO Group, and the American Security Resources Corp, which intends to launch a digital currency exchange. For more information, please see our client alert on this topic.

Conclusion

The glut of announcements and decisions comes at a time when institutional investors are increasingly taking note of the price appreciation of digital currencies. Over the coming months, an ever-growing number of companies will determine and assess whether the technology can fit into both their existing business models and the anticipated legal landscape.

Although regulators throughout the world are considering this new technology and its fit into their existing regulatory regimes, very few regulators have thus far promulgated new rules that target DLT or digital assets. Regulators such as the U.S. CFTC and SEC have applied their existing rules to digital assets through enforcement orders and investigation reports, roping only a subset of DLT products into their respective regulatory regimes. But many DLT products do not fit neatly into a particular regulatory jurisdiction. As a result, much of the ecosystem remains in a grey zone where most regulations arguably do not apply. However, given the recent abundance of activity (which does not show any sign of slowing) this remains a space to watch.